Bitcoin Derivatives Exchange Expands, Skirting China’s Currency Curbs

Bitcoin Mercantile Exchange (BitMEX), a bitcoin derivatives exchange that launched in 2014, already has 5,800 users who have traded $760 million on the exchange, according to Bloomberg.

Started by Arthur Hayes, a former Citigroup trader living in Hong Kong, the goal was to create an exchange where people use cryptocurrency to bet on securities not easily accessible to them in their home markets.

Because China restricts exchanging its yuan for other currencies, citizens find it expensive and difficult to invest in overseas securities. Foreign investors are also restricted in trading China stocks.

Buying Derivatives In Bitcoin

Hayes came up with the idea of allowing Chinese investors to use bitcoin to purchase synthetic versions of foreign stocks that are otherwise off limits, such as Facebook and Apple. Conversely, foreign investors can short a basket of the country’s shares that are not exposed to such strategies.

The goal, said Hayes, is to let anyone bet on anything, at any time.

BitMEX lets traders go to sites like Kraken or Coinbase and exchange funds for bitcoin. They can then open a BitMEX account, deposit the bitcoin, and use it to trade. Investors do not buy stocks. They buy derivatives, which are contracts that simulate indexes or stocks. Profits and losses are calculated in a customer’s BitMEX account. Customers can withdraw the proceeds and convert it back to cash.

BitMEX does not have a license to market to Chinese investors. The company relies on the Chinese government’s permissive approach.

BitMEX Off To A Good Start

Aiding BitMEX is the size of China’s market and Hayes’ experience designing financial contracts. Thus far, 5,800 users have traded $760 million. BitMEX is already profitable, which is rare for startups in the amount of time it has existed.

Hayes said he will allow customers to use cryptocurrencies besides bitcoin if they choose.

Gil Luria, head of technology research at Wedbush Securities Inc., said BitMEX has become an early cryptocurrency derivatives exchange and has benefited from proximity to the Chinese market and Hayes’ experience in derivative trading.

BitMEX took first place last month in a competition among 475 startups in Singapore hosted by Tech in Asia, a technology blog. BitMEX now wants to raise $2 million to grow its offerings.

The company is seeking a partner to distribute products to Chinese retail clients or an established derivatives exchange to provide access to institutional traders. Hayes said the company has already turned down some offers.

Investors Seek Diversification

BitMEX’s timing is good, according to William Bao Bean, a Chinese venture investor. He said investors want to diversify as the economy slows and domestic investments get increasingly unpredictable. Bean is a former Deutsche Bank investment banker running a program for startups called Chinaccelerator.

Hayes grew up in the Detroit suburb of Bloomfield Hills. He attended the University of Pennsylvania’s Wharton School and studied economics, finance and Chinese. He spent a year at the Hong Kong University of Science and Technology.

He learned about trading and derivatives in an internship with Deutsche Bank. He moved to Citigroup in 2011 and focused on exchange traded funds. In 2011, he lost his job as part of 11,000 layoffs.

In launching BitMEX, Hayes tabbed Ben Delo, an Oxford University graduate who developed software for traders. Delo is building BitMEX’s trading platform. Sam Reed, a Milwaukee, Wis.-based web developer, oversees the site’s design.

China is the center of the bitcoin world, with more than 90% of bitcoin’s exchange volume being in the Chinese yuan, according to bitcoincharts.com. China also accounts for most bitcoin mining.

Delo and Hayes took part in a three-month Chinacellerator boot camp that assists entrepreneurs develop businesses. They found that Chinese investors want to be able to borrow capital. Hence, BitMEX has allowed customers to borrow as much as $100 for every $1 in capital, which quadruples what some competitors offer.

Generous Borrowing Fuels Growth

With such borrowing, gains and losses are magnified. An investor can put down $1,000 and buy in bitcoin the equivalent of $100,000 of Facebook stock. Should the stock rise by 5%, the investor makes five times their money. Should it decline by that amount, they lose their $1,000 along with another $4,000.

There is a margin call process to keep traders from losing more than they have. BitMEX monitors customers’ portfolios in real time with a software called KDB+, which high-frequency trading firms use. When a trader can’t meet the requirements, the account liquidates immediately. If losses exceed their exchange balance, those who made money have to help cover the losses.

The system works because the exchange is a zero-sum market that matches trades with investors. One side makes and another side loses at all times, Hayes said.

Some traders lose big sums on the exchange, but it has shown it can withstand these events, said Leonhard Weese, president of the Bitcoin Association of Hong Kong. He said the traders probably see it more as a casino than a hedging platform.

Traders Bet On Various Assets

BitMEX is currently running a test in which traders can bet on the price of virtual currencies, market volatility and an index of the biggest 50 Chinese public companies. The goal is to create products for people to bet on stock indexes, securities, bonds and real-world currencies. Hayes noted that the Chicago Mercantile Exchange allows traders to bet on everything from Latin American currencies to Singaporean fuel to European weather.

Hayes said he needs to raise money to expand and be able to find out if the demand for BitMEX will continue.